Risk Management in Banking Industry

8/7/2019 Risk Management in Banking Industry

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Risk Management in Banking

Industry

Done at United Bank of India

Corporate Accounts Department.



Table of Contents

Topics Page No

1.Executive Summary 3

2.Company Profile 4

3. Objectives of Study 6

4. Methodology 6

3.RBI Guidelines for Investment and Fund Management 7

3.1 Types and Valuation of Securities 9

4. Risk Management: An Overview 15

4.1 Basel II and its Basic Architecture 17

5. Implementation of Basel II in India 19

6. Credit Risk 24

6.1 Capital Charge for Credit Risk 25

7. Market Risk 31

7.1 Scope and Coverage of Market Risk 31

7.2 Capital Charge for Market Risk 31

8. Operational Risk 40

8.1 Measurement Methodologies 40

9. Findings, Recommendation and Conclusion 43

10. Appendix: CRAR Calculation for UBI 44

11. Reference 4812. Glossary 49

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1. Executive Summary

Globalization is the most important factor shaping today’s world. India

is no exception. The financial segments are gearing up to face the global

competitive environment by initiating reforms by adopting prudential

norms, best practices in corporate governance, internal control and risk-

based auditing. There is a sea change in the working of banks. Risk

management has become a new emerging tool used by banks for their

sustainability.

The scope of this project is to give readers a detail account of the risk management scenario in the banking industry of India, with special

emphasis on United Bank of India (UBI).

It deals with the various circulars and prudential norms stipulated by

Reserve Bank of India (RBI) that goes on to implement the

internationally accepted standards that aim at making the banking

industry safe, stable and sound..

Due to reasons of confidentiality the data gathered from the bank’s

books could not be replicated in the project. However, representative

data has been used. With those data the Capital to Risk (Weighted)

Assets Ratio (CRAR) for UBI has been calculated and compared with

that stipulated by the RBI.

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2. Company Profile

United Bank of India (UBI) is one of the 14 major banks which were nationalized

on July 19, 1969. Its predecessor the United Bank of India Ltd., was formed in 1950

with the amalgamation of four banks viz. Comilla Banking Corporation Ltd. (1914),Bengal Central Bank Ltd. (1918), Comilla Union Bank Ltd. (1922) and Hooghly

Bank Ltd. (1932) (which were established in the years indicated in brackets after the

names). The origin of the Bank thus goes back as far as 1914. As against 174

branches, Rs. 147 crores of deposits and Rs. 112 crores of advances at the time of nationalization in July, 1969, today the Bank has 1401 branches, over Rs. 37,167

crores of deposits and Rs. 22,641 crores of gross advances as on 31-03-07. Presentlythe Bank has a three-tier organizational set-up consisting of the Head Office, 28

Regional Offices and 1401 branches

After nationalization, the Bank expanded its branchnetwork in a big way and actively participated in the

developmental activities, particularly in the rural and semi-

urban areas in conformity with the objectives of

nationalization. In recognition of the role played by theBank, it was designated as Lead Bank in several districts

and at present it is the Lead Bank in 30 districts in the

States of West Bengal, Assam, Manipur and Tripura. TheBank is also the Convener of the State Level Bankers'

Committees (SLBC) for the States of West Bengal and

Tripura.

UBI played a significant role in the spread of banking services in different parts of

the country, more particularly in Eastern and North-Eastern India. UBI hassponsored 4 Regional Rural Banks (RRB) one each in West Bengal, Assam,

Manipur and Tripura. These four RRBs together have over 1000 branches. United

Bank of India has contributed 35% of the share capital/ additional capital to all the

four RRBs in four different states. In its efforts to provide banking services to the

people living in the not easily accessible areas of the Sunderbans in West Bengal,UBI had established two floating mobile branches on motor launches which moved

from island to island on different days of the week. The floating mobile brancheswere discontinued with the opening of full-fledged branches at the centers which

were being served by the floating mobile branches. UBI is also known as the 'Tea

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Bank' because of its age-old association with the financing of tea gardens. It has

been the largest lender to the tea industry.

On March 30, 2009, the Indian government decided to approve the

restructuring United Bank of India. The cabinet has approved the

government's proposal to investing 2.50 billion rupees in shares by March 31,and another 5.50 billion in the next fiscal year in Tier-I capital instruments.

The move is part of the Indian government's program to improve the capital

base of the state-owned banks

The Bank has three full fledged Overseas Branches one each at Kolkata, New Delhiand Mumbai with fully equipped dealing room and SWIFT terminal . Theoperations of 500 branches have been computerized either fully or partially and

Electronic Fund Transfer System came to be implemented in the Bank's branches at

Kolkata, Delhi, Mumbai and Chennai. The Bank has ATMs all over the country and

having Cash Tree arrangement with 11 other Banks. The Bank has tie-uparrangement with WESTERN UNION to facilitate foreign currency transfers.

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3. Objective of Study

The objective of the project was to learn and understand the various risk management strategies used in the bank. The purpose was to gain an in-depth

understanding of the Basel II norms of Capital Adequacy and use it to calculate the

Capital Adequacy Ratio of the bank.

4. Methodology

Conventional sources and methods are used to collect data. Reserve Bank India

(RBI) guidelines on Basel I and Basel II and Investment policy guideline of UBI has

been the major sources of information. Other than these sources previous three year

Annual Statement was also referred to gather data pertaining to Eligible CapitalFund and Operational Risk calculation. The ledger books has also come handy to

fathom the bank’s investment position in various financial instruments, viz., Govt.

Securities, CP/CD, Mutual Fund, Venture Capital Funds etc. NCFM study materialon Debt Market module was very helpful in determining the marker risk. It provided

a useful insight about the calculation of Yield, Duration, Modified Duration etc.

Information was also gathered from RBI web site regarding a few macroeconomic

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indicators. Thus data and information was collected from multiple sources.

Other than the above lectures given by my mentor explaining the various aspects of

the workings of the bank and getting hands-on experience in using various bankingtools also helped me in a long way.

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5. RBI GUIDELINES FOR THE INVESTMENT AND FUND

MANAGEMENT:

The main aim of RBI has been to improve the banking industry in India, and tostabilize the securities market. With that view it has introduced certain prudential

norms which have improved the financial position of the Indian banks over last few

years. Simultaneously, trading in securities market has improved in terms of

turnover and the range of maturities dealt with. In view of these developments andtaking into consideration the evolving international practices, Reserve Bank of India

has issued guidelines on classification, valuation and operation of investment

portfolio by banks from time to time.

According to the RBI guidelines the investment portfolio (which includes both SLR & Non – SLR securities) of the bank has to be classified as:

1. Held To Maturity (HTM),

2. Available For Sale (AFS) and

3. Held For Trading (HFT).

However in the balance sheet the entire portfolio shall be classified as:

Government securities.

Other approved securities.

Shares.

Debentures & Bonds.

Subsidiaries/ Joint venture

Others (CP, Mutual Fund Units, etc.).

The category of the investment is to be decided during the time of the investment

itself and the same will be recorded in the proposal.

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Held To Maturity:

The securities which are invested with the objective of holding them till maturity

come under this category. At most 25% of the total investment of the bank can be

included under this category. However there are certain securities which can be

included under this category but will not come under the overall ceiling of 25 %.Such securities are:

• Investment by the bank in subsidiaries and Joint ventures with thesubsidiaries holding more than 25% of equity.

• Debentures bonds which are held as collateral.

• Re- capitalization bonds received from Govt. of India.

Again a bank is allowed to increase the limit of 25% provided the excess inclusion

includes only SLR securities, but the total SLR securities held in the HTM category

shall not be more than 25% of their DTL as on the last Friday of the second preceding fortnight. Non SLR securities which were held in this category as on 2nd

September, 2004 can be kept in HTM category.

The securities held under HTM category are not required to be mark-to-market;instead they are valued at the acquisition cost. If however a security is purchased at

a premium, then the premium will be amortized over the remaining maturity period.However, any diminution, other than temporary, in the value of investments in

Subsidiaries and Joint Ventures will be determined and accordingly will be provided

for each individually. Profit on sale of investments in this category should be first

taken to the Profit & Loss Account and thereafter be appropriated to the ‘CapitalReserve Account’. Loss on sale will be recognized in the Profit & Loss A/c.

Held For Trading:

A security which is purchased with a view to take advantage of the short period price fluctuation and interest rate movement can be categorized under this head. The

security held under this category has to be disposed of within 90 days of its

purchase. The securities should be marked to market at a frequent interval but the book value will not undergo any changes. The net depreciation due to the mark-to-

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market process shall be provided in a separate account and the net appreciation will

not be accounted for. The profit and loss arising from the sale of the securities will

be transferred to Profit & Loss A/c.

Available For Sale:

The securities which cannot be classified under the above two categories will be

included under the AFS category. The valuation of this category is same as the HFTcategory and the profit and loss arising from this category is transferred to the Profit

& Loss A/c.

The extent of securities held in the HFT and AFS category depends upon the bank

itself.

Shifting of the securities between the categories:

The shifting of securities form/to HTM category is possible with the approval of the

Board of Directors. This shifting is allowed once a year generally during the

beginning of the accounting year. A security can be shifted from the AFS category

to HFT category with the approval of the Board of Directors/ALCO etc. But viceversa is not generally allowed unless the securities could not be sold because of tight

liquidity condition, unidirectional market extreme volatility, etc.

During the transfer of securities, they are to be valued at Book Value/Market

Value/Acquisition Cost whichever is less, and should be done after providing for the

depreciation if any.

.

3.1 TYPES AND VALUATION OF SECURITIES:

On a generic note securities can be divided in two broad divisions, namely

• SLR Securities

• Non SLR Securities.

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SLR securities are those securities which are requires to meet the Statutory Liquidity

Requirement. Securities which do not fall under the SLR category are classified as

the Non SLR Securities. Securities can also be categorized as Quoted and Unquotedsecurities. Quoted securities are those which are listed in any exchange, and the

securities

which are not listed are called Unquoted securities.

3.2.1 Valuation of Securities:

Valuation of Quoted Securities:

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The market value for the purpose of periodical valuation of investments included in

the Available for Sale and the Held for trading categories would be the market

price of the scrip from any of the following sources:

Quotes/Trades on the Stock exchanges

SGL Account transactions

Price list of RBIPrices declared by Primary Dealers Association of India (PDAI) jointly with

FIMMDA

Valuation of Unquoted SLR Securities:

Central Govt. Securities should be valued on the basis of the prices/ YTM rates put

out by the PDAI/ FIMMDA at periodical intervals. The 6.00 per cent CapitalIndexed Bonds may be valued at “cost” and Treasury Bills should be valued at

carrying cost.

State Government securities as well as the other approved securities will be valued

applying the YTM method by marking it up by 25 basis points above the yields of

the Central Government Securities of equivalent maturity put out by PDAI/FIMMDA periodically.

Valuation of Unquoted Non-SLR Securities:

A) Debentures/Bonds:

All debentures/ bonds other than debentures/ bonds which are in the nature of

advance should be valued on the YTM basis. Such debentures/ bonds may be of

different companies having different ratings. These will be valued with appropriate

mark-up over the YTM rates for Central Government securities as put out by PDAI/FIMMDA periodically. The mark-up will be graded according to the ratings

assigned to the debentures/ bonds by the rating agencies subject to the following:

• The rate used for the YTM for rated debentures/ bonds should be at least 50

basis points above the rate applicable to a Government of India loan of

equivalent maturity.

• The rate used for the YTM for unrated debentures/ bonds should not be less

than the rate applicable to rated debentures/ bonds of equivalent maturity.The mark-up for the unrated debentures/ bonds should appropriately reflect

the credit risk borne by the bank.

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• Where the debenture/ bonds are quoted and there have been transactions

within 15 days prior to the valuation date, the value adopted should not behigher than the rate at which the transaction is recorded on the stock

exchange.

• Where interest/principle on the debentures/bonds is in arrears, the provisions

will be made for the debentures as in the case of debenture/bonds treated asadvances.

• The depreciation/provision requirements towards debentures where the

interest is in arrears or principal is not paid as per due date shall not be

allowed to be set off against appreciation against other debenture/bonds.

B) Zero Coupon Bonds:

Zero coupon bonds should be shown in the books at carrying cost, i.e., acquisition

cost plus discount accrued at the rate prevailing at the time of acquisition, which

may be marked to market with reference to the market value. In the absence of

market value, the zero coupon bonds may be marked to market with reference to the present value of the zero coupon bond. The present value of the zero coupon bonds

may be calculated by discounting the face value using the Zero Coupon Yield Curve

with appropriate mark up as per the zero coupon spreads put out by FIMMDA

periodically. In case the bank is still carrying the zero coupon bonds at acquisitioncost, the discount accrued on the instrument should be notionally added to the book

value of the scrip, before marking it to market.

C) Preference Shares:

The valuation of preference shares should be on YTM basis. The preference shares

will be issued by companies with different ratings. These will be valued with

appropriate mark-up over the YTM rates for Central Government securities put out

by the PDAI/FIMMDA periodically. The mark-up will be graded according to theratings assigned to the preference shares by the rating agencies subject to the

following:

• The YTM rate should not be lower than the coupon rate/ YTM for a GOI

loan of equivalent maturity.

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• The rate used for the YTM for unrated preference shares should not be less

than the rate applicable to rated preference shares of equivalent maturity.The mark-up for the unrated preference shares should appropriately reflect

the credit risk borne by the bank.

• Investments in preference shares as part of the project finance may be valued

at par for a period of two years after commencement of production or fiveyears after subscription whichever is earlier.

• Where investment in preference shares is as part of rehabilitation, the YTM

rate should not be lower than 1.5% above the coupon rate/ YTM for GOI

loan of equivalent maturity.

• Where preference dividends are in arrears, no credit should be taken for

accrued dividends and the value determined on YTM should be discounted

by at least 15% if arrears are for one year, and more if arrears are for more

than one year. The depreciation/provision requirement arrived at in theabove manner in respect of non-performing shares where dividends are in

arrears shall not be allowed to be set-off against appreciation on other performing preference shares.

• The preference share should not be valued above its redemption value.

• When a preference share has been traded on stock exchange within 15days prior to the valuation date, the value should not be higher than theprice at which the share was traded.

C) Equity Shares:

The equity shares in the bank's portfolio should be marked to market preferably on adaily basis, but at least on a weekly basis. Equity shares for which current quotations

are not available or where the shares are not quoted on the stock exchanges, should be valued at break-up value (without considering ‘revaluation reserves’, if any)

which is to be ascertained from the company’s latest balance sheet (which should

not be more than one year prior to the date of valuation). In case the latest balancesheet is not available the shares are to be valued at Re.1 per company.

D) Mutual Fund Units:

Investment in quoted Mutual Fund Units should be valued as per Stock Exchange

quotations. Investment in un-quoted Mutual Fund Units is to be valued on the basisof the latest re-purchase price declared by the Mutual Fund in respect of each

particular Scheme. In case of funds with a lock-in period, where repurchase price/

market quote is not available, Units could be valued at NAV. If NAV is notavailable, then these could be valued at cost, till the end of the lock-in period.

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Wherever the re-purchase price is not available the Units could be valued at the

NAV of the respective scheme.

E) Venture Capital Fund:

The different quoted securities of VCFs (equity, bond, units etc) in the bank's

portfolio should be held under Available for Sale (AFS) category and marked tomarket at regular close intervals in line with the valuation norms issued by the RBI.

Banks’ investments in unquoted units of VCFs made after August 23, 2006 (i.e.

issuance of guidelines on valuation, classification of investments in VCFs) will be

classified under Held to Maturity (HTM) category for initial period of three years

and will be valued at cost during this period. For the investments made beforeissuance of these guidelines, the classification would be done as per the existing

norms.

After three years these securities should be transferred to AFS category and would be valued as stated below:

• Equity: In the case of investments in the form of shares, the valuation can be

done at the required frequency based on the break-up value (withoutconsidering ‘revaluation reserves’, if any) which is to be ascertained from

the company’s (VCF’s) latest balance sheet (which should not be more than

18 months prior to the date of valuation). Depreciation, if any on the shareshas to be provided at the time of shifting the investments to AFS category as

also on subsequent valuations

• which should be done at quarterly or more frequent intervals. If the latest balance sheet available is more than 18 months old, the shares are to bevalued at Rupee.1.00 per company.

• Bonds: The investment in the bonds of VCFs, if any, should be valued as per

prudential norms for classification, valuation and operation of investment portfolio by banks issued by RBI from time to time.

• Units: In the case of investments in the form of units, the valuation will bedone at the Net Asset Value (NAV) shown by the VCF in its financial

statements. Depreciation, if any, on the units based on NAV has to be

provided at the time of shifting the investments to AFS category from HTM

category as also on subsequent valuations which should be done at quarterlyor more frequent intervals based on the financial statements received from

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the VCF. At least once in a year, the units should be valued based on the

audited results. However, if the audited balance sheet/ financial statements

showing NAV figures are not available continuously for more than 18months as on the date of valuation, the investments are to be valued at Rupee

1.00 per VCF.

Treatment of Broken Period Interest:

The broken period interest paid to the seller as the part of the cost of thesecurities, should not be capitalized. The interest thus paid is to be treated as an

expense and debited to Profit & Loss A/C.

4. Risk Management. An Overview

In the process of financial intermediation banks are exposed to severe competitionthat compels them to encounter various types of financial and non-financial risk.

Risk and uncertainties, therefore form an integral part and parcel of banking.

Business grows mainly by taking risk as greater the risk, higher the profit and hence

the entity must strike a trade off between the two. Risk is the potentiality that both

the expected and unexpected events may have an adverse impact on the bank’scapital and earnings. While the expected losses are generally taken care of by

suitable pricing methodology, the unexpected losses, both on account of individualexposure and the whole portfolio in entirety, is to be borne by the bank itself and

hence is to be taken care of by the requisite capital. Hence the need for suitable

capital structure and sufficient Capital Adequacy Ratio is felt. There will thus be

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enhanced risk sensitivity in the capital allocation process, in future. Regulation of

capital assumes significant importance so as to reduce bank failures; to promote

stability, safety and soundness of the banking system; to prevent systemic disaster and to ultimately reduce losses to the bank depositors.

The Basel Committee on Banking Supervision (BCBS) is a committee of banking

supervisory authorities of G-10 countries and has been developing standards andestablishment of a framework for bank supervision towards strengthening stability

of financial institutions in general and banks in particular. Bankers for

International Settlement (BIS) meet at Basel, situated at Switzerland, to address

the common issues concerning bankers all over the world. The first CapitalAccord1988, which was implemented in India during the economic liberalization

and globalization in 1991, was the first attempt to prescribe rule based Capital

Adequacy norms for all the international banks so as to ensure a level playing fieldfor them. When the BIS came out with its first Accord in 1988 with emphasis on

Capital Adequacy, it was internationally hailed as a milestone in BankingRegulation. The Accord attempted to apply state of the art financial modelingtechniques for capital adequacy requirements.

Though it became a universal benchmark for assessing the adequacy of regulatorycapital, the 1988 capital accord had certain shortcomings, some of which are listed

herein after:

As there were only four risk weights such as 0%,20%, 50% and 100%,

inadequate differentiation of credit risk had inadvertently crept in

In respect of investments, general quantum equivalent to 2.5% risk weight

for the entire portfolio was provided for. (In the new accord, based on amodel capturing the volatility of the market, capital charge is calculated.)

The risk weights applied to AAA rated borrower and that of lower rated borrower are same though the risk profile of the borrowers may vary

substantially relatively. There was no relief of capital to the banks holdingrelatively less risky assets in their books.

Capital charge was same irrespective of the maturity structure of credit

exposure and the accord ignored the fact that there is greater risk of default

in the longer-term exposure than the one maturing shortly

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The accord did not recognize the portfolio diversification effect for creditrisk, though such a treatment was given in respect of market risk.

The availability of certain credit risk mitigation techniques such as cash

margin, collateral security, etc was not recognized

There was no capital charge for the operational risk, though it was a very

important source of risk and may be, at times, more devastating than creditrisk.

In June 2004, the BIS finalised Basel II, after five years of industry and regulatory

consultation. The objective behind this regulation is to align regulatory capital

measures with the inherent risk profile of a bank considering credit, market,operational and other risks.

Basel Capital Accord II (or Basel II, as it is popularly called) recommendation wasthe first among the series of reforms suggested. The greatest drawback of the Basel I proposal was that it prescribed a one- size-fits-all solution for all circumstances and

focused on single risk to measure credit and market risk capital adequacy ratio. It

does not cover the main risk element ‘Operational Risk’. BIS defines operationalrisk as, “the risk of loss resulting from inadequate or failed internal processes,

people and system or from external events.” In short, operational risk identifies:

a. Why loss has happened, and

b. A breakdown of the causes into:

• People

• Process

• System

• External events

4.1 Basel II and Its Basic Architecture

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Even though India has one of the strongest banking systems compared to many peer

group countries, our credit, market and operational risk measurement and

management system is lagging behind the banks of many developed countries. BaselII implementation will certainly improve the working efficiency and

competitiveness of Indian banks. Basel II provides a more comprehensive and

flexible approach for measuring and managingrisk. It adds a new dimension called

operational risk and encourages the bank’s internal risk management methodologies.The new accord is based on three pillars:

Pillar 1: Minimum Capital Requirement

The minimum capital requirement is still kept at 8% of risk weighted assets.

This lays emphasis on regulatory requirement for credit, market and operational

risk. Pillar 1 spells out the capital requirement of a bank in relation to thecredit risk in its portfolio, which is a significant change from the “one size fits

all” approach of Basel I. Pillar 1 allows flexibility to banks and supervisors tochoose from among the Standardised Approach, Internal Ratings Based

Approach, and Securitisation Framework methods to calculate the capital

requirement for credit risk exposures. Besides, Pillar 1 sets out the allocation

of capital for operational risk and market risk in the trading books of banks.

Capital adequacy ratio = (Total Regulatory capital Tier I + Tier II + TierIII)/

Risk weighted assets (Credit + Market + Operational)

To deal with the credit risk, Basel II suggests the following approaches:

a. Standardised Approach

b. Foundation Internal Rating Based (IRB) Approach

c. Advanced Internal Rating Based (IRB) Approach

The first approach requires allocation of risk weight to each of the assets. Bank may use

external credit assessment institutions for determining risk weights. The latter two

approaches require assessment by banks internally using sophisticated models.

Pillar 2: Supervisory Review

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The supervisory review process needs to ensure that each financial institution

adopts effective internal processes for risk management. The supervisory process is based on the following principles. Banks to have:

a. A process for assessing the capital adequacy based on the risk

profile,

b. Strategy for maintaining the capital levels,

c. A system to evaluate and monitor the capital requirement andensure compliance,

d. Mechanism to intervene, prevent at early stage, the capital fromfalling below the minimum levels

.

Pillar 3: Market Discipline

This pillar emphasises the basic need of corporate governance and effective useof market discipline by enhanced disclosure. Pillar 3 provides a framework for

the improvement of banks’ disclosure standards for financial reporting, risk

management, asset quality, regulatory sanctions, and the like. The pillar also

indicates the remedial measures that regulators can take to keep a check on erring banks and maintain the integrity of the banking system. Further, Pillar 3

allows banks to maintain confidentiality over certain information, disclosure of

which could impact competitiveness or breach legal contracts.

Pillar 1 Specifies new standards for minimum capital requirements,

along with the methodology for assigning risk weights on the basis of credit risk and market risk; Also specifies capital requirement for operational risk.

Pillar 2 Enlarges the role of banking supervisors and gives them power to themto review the banks’ risk management systems.

Pillar 3 Defines the standards and requirements for higher disclosure by banks on capital adequacy, asset quality and other risk management

processes

5. Implementation of Basel II in India

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The Reserve Bank of India (RBI) has asked banks to move in the direction of implementing the Basel II norms, and in the process identify the areas that need

strengthening. In implementing Basel II, the RBI is in favour of gradual convergence

with the new standards and best practices. The aim is to reach the global best

standards in a phased manner, taking a consultative approach rather than adirective one.

With a view to adopting the Basle Committee on Banking Supervision (BCBS)

framework on capital adequacy which takes into account the elements of credit risk in various types of assets in the balance sheet as well as off-balance sheet business

and also to strengthen the capital base of banks, Reserve Bank of India decided in

April 1992 to introduce a risk asset ratio system for banks (including foreign banks)in India as a capital adequacy measure. Essentially, under the above system the

balance sheet assets, non-funded items and other off-balance sheet exposures are

assigned prescribed risk weights and banks have to maintain unimpaired minimum

capital funds equivalent to the prescribed ratio on the aggregate of the risk weightedassets and other exposures on an ongoing basis. Reserve Bank has issued guidelines

to banks in June 2004 on maintenance of capital charge for market risks on the lines

of ‘Amendment to the Capital Accord to incorporate market risks’ issued by theBCBS in 1996.

The BCBS released the "International Convergence of Capital Measurement and

Capital Standards: A Revised Framework" on June 26, 2004. The RevisedFramework was updated in November 2005 to include trading activities and the

treatment of double default effects and a comprehensive version of the framework was issued in June 2006 incorporating the constituents of capital and the 1996amendment to the Capital Accord to incorporate Market Risk. The Revised

Framework seeks to arrive at significantly more risk-sensitive approaches to capital

requirements. The Revised Framework provides a range of options for determiningthe capital requirements for credit risk and operational risk to allow banks and

supervisors to select approaches that are most appropriate for their operations and

financial markets.

Parallel Run

With a view to ensuring smooth transition to the Revised Framework and with a

view to providing opportunity to banks to streamline their systems and strategies, banks were advised to have a parallel run of the revised Framework. The Boards of

the banks should review the results of the parallel run on a quarterly basis. The

broad elements which need to be covered during the parallel run are as under:

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i) Banks should apply the prudential guidelines on capital adequacy – both

current guidelines and these guidelines on the Revised Framework – on

an on-going basis and compute their Capital to Risk Weighted AssetsRatio (CRAR) under both the guidelines.

ii) An analysis of the bank's CRAR under both the guidelines should be

reported to the board at quarterly intervals.

iii) A copy of the quarterly reports to the Board should be submitted to theReserve Bank, one each to Department of Banking Supervision, Central

Office and Department of Banking Operations Development, Central

Office. While reporting the above analysis to the board, banks should

also furnish comprehensive assessment of their compliance with theother requirements relevant under the Revised Framework, which will

include the following, at the minimum:

a) Board approved policy on utilization of the credit risk mitigation

techniques, and collateral management, b) Board approved policy on disclosures,c) Board approved policy on Internal Capital Adequacy Assessment

Process (ICAAP) along with the capital requirement as per ICAAP.

d) Adequacy of bank's MIS to meet the requirements under the New Capital

Adequacy Framework, the initiatives taken for bridging gaps, if any, andthe progress made in this regard,

e) Impact of the various elements/portfolios on the bank’s CRAR under the

revised framework,f) Mechanism in place for validating the CRAR position computed as per

the New Capital Adequacy Framework and the assessments / findings/

recommendations of these validation exercises,Action taken with respect to any advice / guidance / direction given by the Board inthe past on the above aspects.

Effective Date

Foreign banks operating in India and Indian banks having operational presence

outside India migrated to the above selected approaches under the RevisedFramework with effect from March 31, 2008. All other commercial banks (except

Local Area Banks and Regional Rural Banks) migrated to these approaches under

the Revised Framework by March 31, 2009.

Scope

The revised capital adequacy norms shall be applicable uniformly to all CommercialBanks (except Local Area Banks and Regional Rural Banks), both at the solo level

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(global position) as well as at the consolidated level. A Consolidated bank is defined

as a group of entities where a licensed bank is the controlling entity. A consolidated

bank will include all group entities under its control, except the exempted entities. Interms of guidelines on preparation of consolidated prudential reports issued vide

circular DBOD. No.BP.BC.72/ 21.04.018/ 2001-02 dated February 25, 2003; a

consolidated bank may exclude group companies which are engaged in insurance

business and businesses not pertaining to financial services. A consolidated bank should maintain a minimum Capital to Risk-weighted Assets Ratio (CRAR) as

applicable to a bank on an ongoing basis.

Implementation

The Revised Framework consists of three-mutually reinforcing Pillars, viz.minimum capital requirements, supervisory review of capital adequacy, and market

discipline. Under Pillar 1, the Framework offers three distinct options for computing

capital requirement for credit risk and three other options for computing capitalrequirement for operational risk. These options for credit and operational risks are

based on increasing risk sensitivity and allow banks to select an approach that is

most appropriate to the stage of development of bank's operations. The optionsavailable for computing capital for credit risk are Standardised Approach,

Foundation Internal Rating Based Approach and Advanced Internal Rating Based

Approach. The options available for computing capital for operational risk are Basic

Indicator Approach, Standardised Approach and Advanced Measurement Approach.

Keeping in view Reserve Bank’s goal to have consistency and harmony with

international standards, it has been decided that all commercial banks in India

(excluding Local Area Banks and Regional Rural Banks) shall adopt Standardised

Approach (SA) for credit risk and Basic Indicator Approach (BIA) foroperational risk . Banks shall continue to apply the Standardised Duration

Approach (SDA) for computing capital requirement for market risks.

Capital Funds

When we say Capital in relation to the financial institution like banks, what we

mean is the Capital Funds, which are the total Owned Funds available to the

Institution for a reasonably long time. The basic approach of capital adequacy

framework is that a bank should have sufficient capital to provide a stable resourceto absorb any losses arising from the risks in its business. Capital is divided into

tiers according to the characteristics/quality of each qualifying instrument.

The Capital Funds consist of Tier I, Tier II and Tier III Capital, the components

of which are explained below:

23



Tier I:

a) Owned Funds: The paid up capital brought in by the owners and is

not envisaged to be repaid during the normal course of the business.

b) Disclosed Reserves - Statutory reserves, capital reserves are thereserves created by appropriation of Retained Earnings (For example

Retained profit, General reserve & other surplus like share premium).

According to RBI, for Indian banks Tier I Capital includes:

i) Paid-up capital (ordinary shares), statutory reserves, and other disclosed free

reserves, if any;ii) Perpetual Non-cumulative Preference Shares (PNCPS) eligible for inclusion

as Tier I capital - subject to laws in force from time to time;

iii) Innovative Perpetual Debt Instruments (IPDI) eligible for inclusion as Tier Icapital;

iv) Capital reserves representing surplus arising out of sale proceeds of assets.

Tier II:

The elements of Tier II capital include undisclosed reserves, revaluation reserves,

general provisions and loss reserves, hybrid capital instruments, subordinated debt

and investment reserve account.

a. Undisclosed reservesThey can be included in capital, if they represent accumulations of post-tax profits

and are not encumbered by any known liability and should not be routinely used for

absorbing normal loss or operating losses.

b. Revaluation reserves

It would be prudent to consider revaluation reserves at a discount of 55 percentwhile determining their value for inclusion in Tier II capital. Such reserves will have

to be reflected on the face of the Balance Sheet as revaluation reserves.

c. General provisions and loss reservesSuch reserves can be included in Tier II capital if they are not attributable to the

actual diminution in value or identifiable potential loss in any specific asset and are

24



available to meet unexpected losses. Adequate care must be taken to see that

sufficient provisions have been made to meet all known losses and foreseeable

potential losses before considering general provisions and loss reserves to be part of Tier II capital. General provisions/loss reserves will be admitted up to a maximum

of1.25 percent of total risk weighted assets.

'Floating Provisions' held by the banks, which is general in nature and not madeagainst any identified assets, may be treated as a part of Tier II capital within the

overall ceiling of 1.25 percent of total risk weighted assets. Excess provisions whicharise on sale of NPAs would be eligible Tier II capital subject to the overall ceiling

of 1.25% of total Risk Weighted Assets

d. Hybrid debt capital instruments

Those instruments which have close similarities to equity, in particular when theyare able to support losses on an ongoing basis without triggering liquidation, may beincluded in Tier II capital

e. Subordinated debt

Banks can raise, with the approval of their Boards, rupee-subordinated debt as Tier II Capital.

f. Investment Reserve Account

In the event of provisions created on account of depreciation in the ‘Available for Sale’ or ‘Held for Trading’ categories being found to be in excess of the required

amount in any year, the excess should be credited to the Profit & Loss account and

an equivalent amount (net of taxes, if any and net of transfer to Statutory Reserves

as applicable to such excess provision) should be appropriated to an InvestmentReserve Account in Schedule 2 –“Reserves & Surplus” under the head “Revenue

and other Reserves” in the Balance Sheet and would be eligible for inclusion under

Tier II capital within the overall ceiling of 1.25 per cent of total risk weighted assets

prescribed for General Provisions/ Loss Reserves.

g. Banks are allowed to include the ‘General Provisions on Standard Assets’ and

‘provisions held for country exposures’ in Tier II capital. However, the provisions

25



on ‘standard assets’ together with other ‘general provisions/ loss reserves’

and‘provisions held for country exposures’ will be admitted as Tier II capital up to a

maximum of 1.25 per cent of the total risk-weighted assets.

6. Credit Risk

Credit risk is most simply defined as the potential that a bank’s borrower or counterparty

may fail to meet its obligations in accordance with agreed terms. It is the possibility

of losses associated with diminution in the credit quality of borrowers or

counterparties. In a bank’s portfolio, losses stem from outright default due to inability or unwillingness

of a customer or a counterparty to meet commitments in relation to lending, trading,

settlement and other financial transactions. Alternatively, losses result fromreduction in

portfolio arising from actual or perceived deterioration in credit quality.

For most banks, loans are the largest and the most obvious source of credit risk;

however, other sources of credit risk exist throughout the activities of a bank,

including in the banking book and in the trading book, and both on and off balancesheet. Banks increasingly face credit risk (or counterparty risk) in various financial

instruments other than loans, including acceptances, inter-bank transactions, trade

financing, foreign exchange transactions, financial futures, swaps, bonds, equities,

options and in guarantees and settlement of transactions.

The goal of credit risk management is to maximize a bank’s risk-adjusted rate of

return by maintaining credit risk exposure within acceptable parameters. Banks need to

manage the credit risk inherent in the entire portfolio, as well as, the risk in theindividual credits or transactions. Banks should have a keen awareness of the need

to identify measure, monitor and control credit risk, as well as, to determine that

26



they hold adequate capital against these risks and they are adequately compensated

for risks incurred.

Basel II provides banks with three approaches for calculation of theminimum capital requirement necessary to cover Credit Risk.

Standardized approachThe Standardised Approach specified under Basel II is more sensitive, vis-

à-vis Basel I, to the credit risks associated with an obligor. The newapproach grades the credit risks of an obligor (both on and off balance sheet

items) by assigning different risk weights on the basis of the creditratings given by external credit assessment institutions (primarily rating

agencies). Under Basel I, on the other hand, different risk weights were

assigned to different types of obligors (sovereign, corporate or banks). To

illustrate, under Basel II, for corporate, the risk weight could vary from aslow as 20% for a Aaa rated obligor to as high as 150% for a B1 or lower

rated obligor, whereas under Basel I, the risk weight for all corporate

borrowers would be a standard 100%. The key obligors that have beendifferentiated under Basel II are sovereigns, corporate, banks, securities

firms, multilateral development banks, non-central government public sector

enterprises, and retail.

Internal Rating-Based Approach (IRB)In this approach, a bank uses its internal ratings, instead of external ratingsas under the Standardised Approach, to measure the credit risk of an obligor.

The IRB Approach is based on the measurement of unexpected loss (UL)and expected loss (EL) derived from four key variables: probability of

default (PD); Loss given default (LGD); exposure at default (EAD); andeffective maturity (M). The banks will have to estimate the potential future

loss from the exposure and assign risk weights accordingly. The IRB

Approach has been further subdivided into Foundation Approach andAdvanced Approach.

In Foundation Approach, a bank would internally estimate the PD and theregulator would provide the other three variables, whereas in Advanced

Approach, the bank would be expected to provide the other three variables

as well. The implementation of IRB approach is subject to explicitapproval of the regulator who would have the discretion to allow the bank concerned to use its internal credit rating systems for assessing credit risk.

Banks would have to satisfy the regulator about the adequacy and

robustness of their risk management systems and internal rating process,

and of their competency in estimating the key variables. The IRB

27



Approach is more risk sensitive as compared with the Standardised

Approach and would benefit banks with improved risk managementsystems, strengthening their risk assessment processes.

6.1 Capital Charge for Credit Risk

Charge on Domestic Sovereigns:1. Both fund based and non fund based claims on the central government will attract a zero

risk weight. Central Government guaranteed claims will attract a zero risk weight.

2. The Direct loan / credit / overdraft exposure, if any, of banks to the State Governmentsand the investment in State Government securities will attract zero risk weight. State

Government guaranteed claims will attract 20 per cent risk weight’.

3. The risk weight applicable to claims on central government exposures will also apply to

the claims on the Reserve Bank of India, DICGC and Credit Guarantee Fund Trust for Small Industries (CGTSI). The claims on ECGC will attract a risk weight of 20 per cent.

4. The above risk weights for both direct claims and guarantee claims will beapplicable as long as they are classified as ‘standard’/ performing assets. Where

these sovereign exposures are classified as non-performing, they would attract risk

weights as applicable to NPAs, as under:

(i) 150 per cent risk weight when specific provisions are less than 20 per cent of the outstanding amount of the NPA;

(ii) 100 per cent risk weight when specific provisions are at least 20 per

cent of the outstanding amount of the NPA;

(iii) 50 per cent risk weight when specific provisions are at least 50 per

cent of the outstanding amount of the NPA.

Charge on Foreign Sovereigns:

1. Claims on foreign sovereigns will attract risk weights as per the rating assigned to thosesovereigns / sovereign claims by international rating agencies as follows:

28



1 2 3 4 5

9 and above Higher of 100 % or

the risk weight as

per the rating of theinstrument or

counterparty,

whichever is higher

20 Higher of 100 % or the

risk weight as per the

rating of theinstrument or

counterparty,

whichever is higher

100

6 to < 9 150 50 250 150

3 to < 6 250 100 350 250

0 to < 3 350 150 625 350

Negative 625 625 Full deduction* 625

The claims on foreign banks will be risk weighted as under as per the ratingsassigned by international rating agencies.

Risk weights S

&P / FITCH ratings

AAA to AA A BBB BB to B Below B Unrated

Moody’s ratings Aaa to Aa A Baa Ba to B Below B Unrated

Risk weight 20 % 50 % 50 % 100 % 150 % 50 %

Charge on Corporates

Domestic rating agencies AAA AA A BBB BB & below Unrated

Risk weight 20 % 30% 50 % 100 % 150 % 100 %

Short Term Claims on Corporate - Risk Weights Short Term Ratings

Short Term Ratings

CARE CRISIL Fitch ICRA Risk Weights

PR1+ P1+ F1+(ind) A1+ 20 %

PR1 P1 F1(ind) A1 30 %

PR2 P2 F2(ind) A2 50 %

PR3 P 3 F3 (ind) A3 100 %

PR4 & PR5 P 4 & P5 F4/F5 (ind) A4 / A5 150 %

Unrated Unrated Unrated Unrated 100 %

30



Charges on Residential Property

Amount of loan Risk weight

Up to Rs.30 lakh 50 %

Rs. 30 lakh and above 75 %

Off Balance Sheet Items

The total risk weighted off-balance sheet credit exposure is calculated as the sum of the risk-weighted amount of the market related and non-market related off-balancesheet items. The risk- weighted amount of an off-balance sheet item that gives rise

to credit exposure is generally calculated by means of a two-step process:

a) The notional amount of the transaction is converted into a credit equivalentamount, by multiplying the amount by the specified credit conversion factor (CCF)

or by applying the current exposure method, and

b) The resulting credit equivalent amount is multiplied by the risk weight

applicable to the counterparty or to the purpose for which the bank has extended

finance or the type of asset, whichever is higher.

The credit conversion factors for non-market related off-balance sheettransactions are as under:

Sr.

No.

Instruments Credit Conversion

Factor (%)

1. Direct credit substitutes e.g. general guarantees of indebtedness

(including standby L/Cs serving as financial guarantees for loans and

securities, credit enhancements, liquidity facilities for securitisation

transactions), and acceptances (including endorsements with thecharacter of acceptance).

(i.e., the risk of loss depends on the credit worthiness of the

counterparty or the party against whom a potential claim is acquired)

100

31



2. Certain transaction-related contingent items (e.g. performance bonds,

bid bonds, warranties, indemnities and standby letters of credit related

to particular transaction).

50

3. Short-term self-liquidating trade letters of credit arising from the

movement of goods (e.g. documentary credits collateralised by the

underlying shipment) for both issuing bank and confirming bank.

20

4. Sale and repurchase agreement and asset sales with recourse, where the

credit risk remains with the bank.

(These items are to be risk weighted according to the type of asset andnot according to the type of counterparty with whom the transaction

has been entered into.)

100

5. Forward asset purchases, forward deposits and partly paid shares and

securities, which represent commitments with certain drawdown.

(These items are to be risk weighted according to the type of asset and

not according to the type of counterparty with whom the transaction

has been entered into.)

100

6 Lending of banks’ securities or posting of securities as collateral by

banks, including instances where these arise out of repo style

transactions (i.e., repurchase / reverse repurchase and securities

lending / securities borrowing transactions)

100

7. Note issuance facilities and revolving / non-revolving underwritingfacilities.

50

8 Commitments with certain drawdown 100

9. Other commitments (e.g., formal standby facilities and credit lines)

with an original maturity of

a) up to one year b) over one year.

Similar commitments that are unconditionally cancellable at any time

by the bank without prior notice or that effectively provide for

automatic cancellation due to deterioration in a borrower’s credit

worthiness

20

50

0

Eligible External Credit Rating Agencies

In accordance with the principles laid down in the Revised Framework, the Reserve

32



Bank of India has decided that banks may use the ratings of the following domestic

credit rating agencies for the purposes of risk weighting their claims for capital

adequacy purposes:

a) CARE Limited

b) CRISIL Limited

c) FITCH India, and

d) ICRA Limited

The RBI has decided that banks may use the ratings of the following internationalcredit rating agencies for the purposes of risk weighting their claims for capital

adequacy purposes where specified:

a) FITCH

b) Moody’s, and

c) Standard & Poors

7. Market Risk

33



Market risk refers to the risk to a bank resulting from movements in market prices in

particular changes in interest rates, foreign exchange rates and equity and

commodity prices. In simpler terms, it may be defined as the possibility of loss to a bank caused by changes in the market variables. The Bank for International

Settlements (BIS) defines market risk as “the risk that the value of ‘on’ or ‘off’

balance sheet positions will be adversely affected by movements in equity and

interest rate markets, currency exchange rates and commodity prices”. Thus, MarketRisk is the risk to the bank’s earnings and capital due to changes in the market level

of interest rates or prices of securities, foreign exchange and equities, as well as, thevolatilities of those changes.

The market risk positions subject to capital charge requirement are:

(i) The risks pertaining to interest rate related instruments and equities in

the trading book; and

(ii) Foreign exchange risk (including open position in precious metals)

throughout the bank (both banking and trading books).

7.1 Scope and coverage of capital charge for market risks

These guidelines seek to address the issues involved in computing capital charges for interest rate related instruments in the trading book, equities in the trading book and foreign

exchange risk (including gold and other precious metals) in both trading and banking books.

Trading book for the purpose of capital adequacy will include:

(i) Securities included under the Held for Trading category

(ii) Securities included under the Available for Sale category

(iii) Open gold position limits

(iv) Open foreign exchange position limits(v) Trading positions in derivatives, and

(vi) Derivatives entered into for hedging trading book exposures.

Banks are required to manage the market risks in their books on an ongoing basis and

ensure that the capital requirements for market risks are being maintained on a

continuous basis, i.e. at the close of each business day. Banks are also required to

maintain strict risk management systems to monitor and control intra-day exposures to

market risks.

Capital for market risk would not be relevant for securities, which have already matured

and remain unpaid. These securities will attract capital only for credit risk. On

completion of 90 days delinquency, these will be treated on par with NPAs for deciding

the appropriate risk weights for credit risk.

34



7.2 Measurement of capital charge for interest rate risk

This section describes the framework for measuring the risk of holding or taking positions in debt securities and other interest rate related instruments in the trading

book.

The capital charge for interest rate related instruments would apply to currentmarket value of these items in bank's trading book. Since banks are required to

maintain capital for market risks on an ongoing basis, they are required to mark to

market their trading positions on a daily basis. The current market value will be

determined as per extant RBI guidelines on valuation of investments.

The minimum capital requirement is expressed in terms of two separately calculated

charges:

(i) "specific risk " charge for each security, which is designed to protect against anadverse movement in the price of an individual security owing to factors related tothe individual issuer, both for short (short position is not allowed in India except in

derivatives) and long positions, and

(ii) "general market risk " charge towards interest rate risk in the portfolio, where

long and short positions (which is not allowed in India except in derivatives) indifferent securities or instruments can be offset.

i) Specific risk

The capital charge for specific risk is designed to protect against an adverse

movement in the price of an individual security owing to factors related to theindividual issuer The risk weights to be used in this calculation must be consistent

with those used for calculating the capital requirements in the banking book. Thus,

banks using the standardised approach for credit risk in the banking book will usethe standardised approach risk weights for counterparty risks in the trading book in a

consistent manner.

35



Capital Charge for Sovereign securities issued by Indian and foreignsovereigns – Held by banks under the HFT Category

36



Sr .No.

Nature of Investment Residual Maturity Specific risk capital (as % of exposure)

A.

Indian Central Government and State Governments

1.

Investment in Central and StateGovernment Securities

All 0.00

2.

Investments in other approvedsecurities guaranteed byCentral Government

All 0.00

3.

Investments in other approvedsecurities guaranteed by StateGovernment

6 months or less 0.28

More than 6 months and up to andincluding 24 months

More than 24 months 1.80

4.

Investment in other securitieswhere payment of interest andrepayment of principal areguaranteed by CentralGovernment

All 0.00

5.

Investments in other securitieswhere payment of interest andrepayment of principal areguaranteed by StateGovernment.



1.13


B.

Foreign Central Governments

1.

AAA to AA All 0.00

2.

A to BBB 6 months or less 0.28


1.13


3.

BB to B All 9.00

4.

Below B All 13.50

5.

Unrated All 13.50

37



Alternative Total Capital Charge for securities issued by Indian and foreign

sovereigns – Held by banks under AFS Category

No. Nature of Investment Residual Maturity Specific risk

capital (as % of

exposure)

A. Indian Central Government and State Governments

1. Investment in Central and State Government

Securities

All 0.00

2. Investments in other approved securities

guaranteed by Central Government

All 0.00

3. Investments in other approved securities

guaranteed by State Government

All 1.80

4. Investment in other securities where payment

of interest and repayment of principal are

guaranteed by Central Government

All 0.00

5. Investments in other securities where payment

of interest and repayment of principal are

guaranteed by State Government.

All 1.80

B. Foreign Central Governments

1. AAA to AA All 0.00

2. A All 1.80

3. BBB All 4.50

4. BB to B All 9.00

5. Below B All 13.50

Unrated All 9.00

38



Specific risk capital charge for bonds issued by banks – Held by banks under

the HFT category

Level of

CRAR

(where

available)

(in per cent)

Residual

maturity

Specific risk capital charge

All Scheduled Banks

(Commercial, Co-Operative

and Regional Rural Banks)

All Non-Scheduled Banks

(Commercial, Co-Operative and

Regional Rural Banks)

Investments

within 10%

limit

referred to

in para 4.4.8

(in per

cent )

All other

claims

(in per cent )

Investments within

10% limit referred

to in para 4.4.8

(in per cent)

All other

claims

(in per cent)

1 2 3 4 5 6

6 9 and above 6 months or

less

1.40 0.28 1.40 1.40

Greater than

months and

up to and

including 24

months

5.65 1.13 5.65 5.65

Exceeding 24

months

9.00 1.80 9.00 9.00

6 to < 9 All maturities 13.50 4.50 22.50 13.50



Negative All maturities 56.25 56.25 Full deduction 56.25

Alternative Total Capital Charge for bonds issued by banks – Held by banksunder AFS category

Level of CRAR

(where available)

(in %)

Alternative Total Capital Charge

All Scheduled Banks

(Commercial, Co-operative and RegionalRural Banks)

All Non-Scheduled Banks

(Commercial, Co-operative andRegional Rural Banks)

39



Investments within 10

% limit

(in %)

All other

claims

(in%)

Investments

within 10 % limit

(in %)

All other claims

(in %)

1 2 3 4 5

9 and above 9.00 1.80 9.00 9.00

6 to < 9 13.50 4.50 22.50 13.50

3 to < 6 22.50 9.00 31.50 22.50

0 to < 3 31.50 13.50 50.00 31.50

Negative 56.25 56.25 Full deduction

Specific Risk Capital Charge for Corporate Bonds (Other than bank bonds) – Held by banks under HFT Category

Rating Residual maturity Specific Risk Capital

Charge (in %)

AAA to BBB


Greater than 6 months and upto and including 24 months

1.14

Exceeding 24 months 1.80

BB and below All maturities 13.5

Unrated (if permitted) All maturities 9

Alternative Total Capital Charge for Corporate Bonds (Other than bank

bonds) – Held by banks under AFS Category

Rating by

the ECAI

Total Capital Charge

(in per cent)

AAA 1.8

AA 2.7

40



A 4.5

BBB 9

BB and below 13.5

Unrated 9

ii) General Market Risk

The capital requirements for general market risk are designed to capture the risk of loss arising from changes in market interest rates. The capital charge is the sum of

four components:

(i) The net short (short position is not allowed in India except in derivatives) or long position in the whole trading book;

(ii) A small proportion of the matched positions in each time-band (the “vertical

disallowance”);

(iii) A larger proportion of the matched positions across different time-bands (the“horizontal disallowance”), and

(iv) A net charge for positions in options, where appropriate.

The Basle Committee has suggested two broad methodologies for computation of

capital charge for market risks. One is the standardised method and the other is the banks’ internal risk management models method. As banks in India are still in a

nascent stage of developing internal risk management models, it has been decidedthat, to start with, banks may adopt the standardised method. Under the standardised

method there are two principal methods of measuring market risk, a “maturity”method and a “duration” method. As “duration” method is a more accurate method

of measuring interest rate risk, it has been decided to adopt standardised duration

method to arrive at the capital charge. Accordingly, banks are required to measurethe general market risk charge by calculating the price sensitivity (modified

duration) of each position separately. Under this method, the mechanics are as

follows:

(i) First calculate the price sensitivity (modified duration) of each instrument;

(ii) Next apply the assumed change in yield to the modified duration of eachinstrument between 0.6 and 1.0 percentage points depending on the maturity

of the instrument (see Table 1 below);

41



(iii) Slot the resulting capital charge measures into a maturity ladder with the fifteen

time bands as set out in Table 1

(iv) Subject long and short positions (short position is not allowed in India except in

derivatives) in each time band to a 5 per cent vertical disallowance designed

to capture basis risk; and

(v) Carry forward the net positions in each time-band for horizontal offsetting

subject to the disallowances set out in Table 2

Table 1. Duration method – time bands and assumed changes in yield

Time Bands Assumed

Change in Yield

Time Bands Assumed Change

in Yield

Zone 1 Zone 3

1 month or less 1.00 3.6 to 4.3 years 0.75

1 to 3 months 1.00 4.3 to 5.7 years 0.70

3 to 6 months 1.00 5.7 to 7.3 years 0.65

6 to 12 months 1.00 7.3 to 9.3 years 0.60Zone 2 9.3 to 10.6 years 0.60

1.0 to 1.9 years 0.90 10.6 to 12 years 0.60

1.9 to 2.8 years 0.80 12 to 20 years 0.60

2.8 to 3.6 years 0.75 over 20 years 0.60

Table 2: Horizontal DisallowanceZones Time Band Within the

Zones

Between

adjacent Zones

Between Zones

1 and 3

Zone 1

1 month or less

40%

40%

40%

100%

1 to 3 month

3 to 6 month

6 to 12 month

Zone 2

1.0 to 1.9 years

30%1.9 to 2.8 years

2.8 to 3.6 years

Zone 3

3.6 to 4.3 years

30%

4.3 to 5.7 years

5.7 to 7.3 years

7.3 to 9.3 years

9.3 to 10.6 years

10.6 to 12 years

12 to 20 years

Over 20 years

Measurement of capital charge for equity risk

The capital charge for equities would apply on their current market value in bank’s

trading book. Minimum capital requirement to cover the risk of holding or taking positions in equities in the trading book is set out below. This is applied to all

42



instruments that exhibit market behaviour similar to equities but not to non-

convertible preference shares (which are covered by the interest rate risk

requirements described earlier). The instruments covered include equity shares,whether voting or non-voting, convertible securities that behave like equities, for

example: units of mutual funds, and commitments to buy or sell equity.

Specific and general market risk

Capital charge for specific risk (akin to credit risk) will be 9 per cent and specific risk is

computed on the banks’ gross equity positions (i.e. the sum of all long equity positions and

of all short equity positions – short equity position is, however, not allowed for banks in

India). The general market risk charge will also be 9 per cent on the gross equity positions.

Aggregation of the capital charge for market risks

As explained earlier capital charges for specific risk and general market risk are to

be computed separately before aggregation. For computing the total capital chargefor market risks, the calculations may be plotted in the following table:

Proforma

Risk category Capital Charge

I. Interest Rate (a+b)

a. General Market Risk

i) Net position (parallel shift)

ii) Horizontal Disallowance (curvature)

iii) Vertical Disallowance (basis)iv) Options

b. Specific Risk II. Equity (a+b)

a. General Market Risk

b. Specific Risk

III. Foreign Exchange and gold

IV. Total Capital Charge for Market Risk

8. Operational Risk

43



The key difference of the new accord is the introduction of operational risk. The

growing number of operational loss events worldwide has forced the management of the banks to look into this aspect more critically to prevent any frauds, reduce errors

by implementing controls as a part of operating process.

Evolving banking practices suggest that the risk other than credit and market riskscan be substantial.Operational risk is defined as the risk of loss resulting from inadequate or failed

internal processes, people and systems or from external events. This definition

includes legal risk, but excludes strategic and reputational risk. Legal risk includes, but is not limited to, exposure to fines, penalties, or punitive damages resulting from

supervisory actions, as well as private settlements.

8.1 The measurement methodologies

The New Capital Adequacy Framework outlines three methods for calculatingoperational risk capital charges in a continuum of increasing sophistication and risk

sensitivity:

i) The Basic Indicator Approach (BIA),ii) The Standardised Approach (TSA), and

iii) Advanced Measurement Approaches (AMA).

Banks are encouraged to move along the spectrum of available approaches as they

develop more sophisticated operational risk measurement systems and practices.

i) Basic Indicator Approach (BIA)

To begin with, banks in India shall compute the capital requirements for operationalrisk under the Basic Indicator Approach. Under BIA approach banks must hold

capital for operational risk equal to the average over the previous three years of a

fixed percentage (denoted as alpha) of positive annual gross income. The charge as

has been explained earlier may expressed as follows:

KBIA = [ ∑ (GI1…n x α )]/nWhere,

KBIA = the capital charge under the Basic Indicator Approach

GI = annual gross income, where positive, over the previous three yearsn = number of the previous three years for which gross income is positive

α = 15%, which is set by the BCBS, relating the industry wide level of requiredcapital to the industry wide level of the indicator.

44



• Gross income is defined as “Net interest income” plus “net non-interest

income”. It is intended that this measure should:

i) be gross of any provisions (e.g. for unpaid interest) and write-offs made

during the year,

ii) be gross of operating expenses, including fees paid to outsourcing service

providers, in addition to fees paid for services that are outsourced, fees received by banks that provide outsourcing services shall be included in the definition of gross

income,

iii) exclude reversal during the year in respect of provisions and write- offs

made during the previous year(s),

iv) exclude income recognised from the disposal of items of movable and

immovable property,

v) exclude realised profits/losses from the sale of securities in the HTMcategory,

vi) exclude income from legal settlements in favour of the bank,

vii) exclude other extraordinary or irregular items of income and expenditure and

viii) exclude income derived from insurance activities (i.e. income derived by

writing insurance policies) and insurance claims in favour of the bank.

• Banks are advised to compute capital charge for operational risk under

the BIA approach as follows:a) Average of [Gross Income * alpha] for each of the last three financial years,

excluding years of negative or zero gross income

b) Gross income = Net profit (+) Provisions & contingencies (+)operating

expenses (Schedule 16) (–) items (iii) to (viii) of above paragraph

c) Alpha = 15%

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ii) The Standardised Approach (TSA)

Under the standardized approach, bank’s activities are divided into eight business

lines. Within each business line, gross income is considered as a broad indicator for the likely scale of operational risk. Capital charge for each business line is

calculated by multiplying gross income by a factor (denoted beta) assigned to that

business line. Total capital charge is calculated as the three-year average of thesimple summations of the regulatory capital across each of the business line in each

year. The values of the betas prescribed for each business line are as under:

Business Line Beta FactorCorporate finance 18%

Trading and sales 18%

Retail banking 12%

Commercial banking 15%

Payment and settlement 18%

Agency services 15%

Asset management 12%

Retail brokerage 12%

iii) Advanced Measurement Approach

Under advanced measurement approach, the regulatory capital will be equal to the risk

measures generated by the bank’s internal risk measurement system using the prescribed

quantitative and qualitative criteria.

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9. Findings, Recommendations and Conclusion

As will be shown in the Appendix below the Capital to Risk Weighted Assets(CRAR) for United Bank of India is 12.80%. So the bank is comfortably

maintaining the prescribed guidelines of Reserve Bank of India which maintains that

banks operating in India should have CRAR of 9%.But UBI uses Standardised Approach to measure Credit Risk of its investments and

Basic Indicator Approach to measure the capital charge for Operational Risk. It has

not been able to migrate to the more advanced approsches like Internal Rating BasedApproach (for Credit Risk) or Beta Method (for Operational Risk) as given by the

Basel Committee for Banking Supervision (BCBS) and ratified by RBI. This

remains a challenge for UBI.

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10. AppendixCRAR Calculation for UBI.

COMPUTATION OF CAPITAL ADEQUACY AS PER BASEL- II NORMS

Statement of Capital Funds,Risk Weighted Assets and CRAR Ratio : As on 31.03.2010

Capital Funds and Risk Assets Ratio

Amount (Rs in thousand)

Capital Funds

Tier -I Capital

1 Unadjusted Tier-I capital

1.1 Paid up Capital 3160000

1.2 Share Premium Reserves 2610000

1.3 Statutory and other disclosed free Reserves 3260000

1.4 Revenue Reserve 5240000

1.5 Capital Reserves 14710000

1.6 Perpetual Non-Cumulative Preference Shares (PNCPS) 5500000

1.7 Innovative Perpetual Debt Instruments

a) Denominated in Indian rupees b) Denominated in foreign currency

1.8 Any other instrument permitted by RBI

( Details of Unadjusted Tier I capital for Indian Banks)

1.9 Surplus in the Profit and Loss Account brought forward

1.10 Current year unallocated surplus in Profit and Loss Account

Total unadjusted Tier I capital 34480000

2 Deductions

2.1 Intangible Assets

I) Accumulated losses

ii) Current period losses

iii) Deferred Tax Asset (DTA) 300000

iv) DTA not relating to accumulated losses, net of DTL

v) Goodwill

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vi) Other intangible assets

(Details of Other Intangible assets to be deducted)

Total intangible assets to be deducted (sum of I to VI) 300000

3 Adjusted Tier I capital (Unadjusted Tier I Capital -

Deductions)

34180000

Tier-II Capital

4 Unadjusted Tier II capital

I) Innovative Perpetual Debt Instruments in excess of 15% of Tier I

capital

II) Revaluation Reserves discounted at 55% of 4516405 2029500

III) General Provisions and loss Reserves 2160000

IV) Perpetual Non-Cumulative Preference Shares

V) Preference Shares

a) Perpetual Cumulative Preference Shares

b) Redeemable Non-Cumulative Preference Shares

c)Redeemable Cumulative Preference Shares

VI) Upper Tier II bonds @

a) Denominated in Indian rupees 5750000

b) Denominated in foreign currency

VII) Lower Tier II instrument (Subordinated debt @ )

a) Denominated in Indian rupees 9500000

b) Denominated in foreign currency

VIII) Any other item permitted by RBI

Total unadjusted Tier II capital 19439500

5 Deductions

5.1 Total deductions 0

6 Adjusted Tier II Capital (Unadjusted Tier II Capital -

Deductions)

19439500

Total Regulatory Capital (Adjusted Tier I + Tier II) 53619500

7 Risk-weighted exposures

7.1 Credit-risk-weighted exposures

a) On-balance sheet exposures excluding securitisation exposures 336590000

b) Off- balance sheet exposures excluding securitisation exposures

I) non-market related 13320000

ii) market-related

Total 13320000

Total credit-risk-weighted exposures 349910000

7.2 Market-risk-weighted exposures 45087060

7.3 Operational-risk-weighted exposures 24183333

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8 Total Risk-Weighted Assets (RWA) 419180393

9 Tier I CRAR (%) 8.15

10 Tier II CRAR (%) 4.64

11 Total CRAR (%) 12.80

Computation of Capital Charge for Operational Risk under Basic Indicator

Approach (BIA) As on 31.03.2010

(Rs. in thousand)

GROSS INCOME 2008-09 2007-08 2006-07

Net Profit 1840000 3180000 2670000 Provisions & Contingencies 7010000 6650000 6830000

Operating Expenses under Schedule 16 9750000 9030000 7780000

TOTAL (A) 18610000 18870000 17290000

Less:

Reversal made in respect of provisions 530000 2420000 430000

Reversal made in respect of write-offs 1550000 2740000 1880000

Gross. Income recognised from the disposal of

items of movable and immovable property000 000 10000

Realised Profits/Losses from the sale of securities

in the "Held to Maturity" Category1470000 120000 50000

Income from legal settlements in favour of the bank

0 0 0

Other extraordinary or irregular items of income 0 0 0

Other extraordinary or irregular items of

expenditure0 0 0

Income derived from Insurance activities ( writing

insurance Policies)0 0 0

Insurance Claims in favour of the bank 0 0 0

TOTAL (B) 3560000 5300000 2380000

GROSS INCOME (C= A-B) 15050000 13570000 14910000

(Rs. in thousand)

Computation of Capital Charge (BIA)1 α (alpha) 15%

2 Gross Income

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2a 2008-09 15050000

2b 2007-08 13570000

2c 2006-07 14910000

3 Average of Gross Income 14510000

4 =

(3x1)Capital Charge 2176500

5 Capital to Risk Weighted Assets % 9%

6 Equivalent Risk Weighted Assets 24183333

Risk Weighted Asset for Market Risk

EXPOSURE RWA Amount in Rs.

On interest rate related

exposuresSpecific Risk 10320 ,84 ,25 ,000 658 ,58 ,81 ,000

General Market Risk 10320 ,84 ,25 ,000 2955 ,69 ,53 ,000

On Equity related

exposures

Specific Risk 444 ,71 ,12 ,000 444 ,71 ,12 ,000

General Market Risk 444 ,71 ,12 ,000 444 ,71 ,12 ,000

Foreign Exchange open

position limit

5 ,00 ,00 ,000.00

5 ,00 ,00 ,000.00

Adjusted value of Interest

Rate Swap

0.00

0.00

TOTAL 21536 ,10 ,75 ,523.72 4508 ,70 ,60 ,000.00

(Note: The above figures are not actual data from the books of UBI.

The numbers are representative of the original data. Original data

could not be given abiding by the privacy and confidentiality policy

of the bank. The above tables are prepared by carefully goingthrough the books of UBI such that the figures represent that of

UBI within the boundaries of confidentiality. The tables have been

prepared and published under the permission of competent

authority.)

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11. REFERENCE

a) RBI Guidelines for Implementation of the New Capital AdequacyFramework (Basel II)

b) Prudential norms on Capital Adequacy and Market Discipline- NewCapital Adequacy Framework (NCAF)

DBOD.No.BP.BC. 73 /21.06.001/2009-10 DATED: February 10, 2010

c) Study material, NCFM Debt Market

d) UBI Annual Report (Previous three years)

e) Ref. www.rbi.gov

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12. GLOSSARY

1 Asset An asset is anything of value that is owned by a

person or business.

2 Available for Sale The securities available for sale are those

securities where the intention of the bank isneither to trade nor to hold till maturity. Thesesecurities are valued at the fair value which is

determined by reference to the best available

source of current market quotations or other data relative to current value.

3 Banking Book The banking comprises assets and liabilities,which are contracted basically on account of relationship or for steady income and statutory

obligations and are generally held till maturity.

4 Basel Committee on

Banking Supervision

The Basel Committee is a committee of bank

supervisors consisting of members from each of

the G10 countries. The Committee is a forumfor discussion on the handling of specific

supervisory problems. It coordinates the sharing

of supervisory responsibilities among national

authority in respect of banks’ foreign

establishments with the aim of ensuringeffective supervision of banks activities

worldwide.

5 Basis Risk The risk that the interest rate of different assets,

liabilities and off-balance sheet items may

change in different magnitude is termed is

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termed as basis risk.

6 Capital Adequacy A measure of the adequacy of an entity'scapital resources in relation to its current

liabilities and also in relation to the risksassociated with its assets ensures that the entity

has sufficient capital to support its activities and

that its net worth is sufficient to absorbadverse changes in the value of its assets without

becoming insolvent.

For example, under BIS (Bank for International

Settlements) rules, banks are required tomaintain a certain level of capital against their

risk-adjusted assets.

7 Capital reserves That portion of a company's profits not paidout as dividends to shareholders. They are also

known as undistributable reserves.

8 Convertible Bonds A bond giving the investor the option to

convert the bond into equity at a fixedconversion price or as per a pre-determined

pricing formula.

9 Core Capital Tier I capital is generally referred to as Corecapital.

10 Credit Risk Risk that a party to a contractual agreement or transaction will be unable to meet their obligations or will default on commitments.

Credit risk can be associated with almost any

transaction or instrument such as swaps, repos,

CDs, foreign exchange transactions, etc.

Specific types of credit risk include sovereignrisk, country risk, legal or force major risk,

marginal risk and settlement risk.

11 Debentures Bonds issued by a company bearing a fixedrate of interest usually payable half yearly on

specific dates and principal amount repayable ona particular date on redemption of the

debentures

12 Deferred Tax Assets Unabsorbed depreciation and carry forward of losses which can be set-off against future taxable

income which is considered as timing differences

result in deferred tax assets. The deferred TaxAssets are accounted as per the Accounting

Standard 22.

Deferred Tax Assets have an effect of decreasing future income tax payments, which

indicates that they are prepaid income taxes and

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meet definition of assets. Whereas deferredtax liabilities have an effect of increasing

future year's income tax payments, which

indicates that they are accrued income taxes andmeet definition of liabilities.

13 Derivative A derivative instrument derives much of its

value from an underlying product. Examples of derivatives include futures, options, forwards

and swaps. For example, a forward contract

can be derived from the spot currency market andthe spot markets for borrowing and lending. In

the past, derivative instruments tended to be

restricted only to those products

which could be derived from spot markets.However, today the term seems to be used for any

product that can be derived from many others.

14 Duration Duration (Macaulay duration) measures the price volatility of fixed income securities. It is

often used in the comparison of the interestrate risk between securities with different

coupons and different maturities. It is theweighted average of the present value of all the

cash flows associated with a fixed income

security. It is expressed in years. The duration of

a fixed income security is always shorter thanits term to maturity, except in the case of zero

coupon securities where they are the same.

15 Foreign InstitutionalInvestors

An institution established or incorporatedoutside India which proposes to invest in Indian

securities provided that a domestic asset

management company or domestic portfolio

manager who manages funds raised or

collected or brought from outside India for

investment in India on behalf of a sub-account,shall be deemed to be a Foreign Institutional

Investor.

16 Forward Contract A forward contract is an agreement between two

parties to buy or sell an agreed amount of acommodity or financial instrument at an agreed

price, for delivery on an agreed future date. Incontrast to a futures contract, a forward

contract is not transferable or exchangetradable, its terms are not standardized

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and no margin is exchanged. The buyer of the

forward contract is said to be long the contract

and the seller is said to be short the contract.

17 General provision and lossReserve

Such reserves, if they are not attributable to theactual diminution in value or identifiable potential loss in any specific asset and are

available to meet unexpected losses, can beincluded in Tier II capital.

18 General Risk Risk that relates to overall market conditions

while specific risk is risk that relates to the issuer of a particular security.

19 Hedging Taking action to eliminate or reduce exposure to

risk.

20 Held for Trading Securities where the intention is to trade bytaking advantage of short-term price / interest rate

movements.

21 Horizontal Disallowance A disallowance of offsets to required capitalused the BIS Method for assessing market risk for regulatory capital. In order to calculate the

capital required for interest rate risk of a trading

portfolio, the BIS Method allows offsets of long

and short positions. Yet interest rate risks of

instruments at different horizontal points of the

yield curve are not perfectly correlated. Hence,the BIS Method requires that a portion of these

offsets be disallowed.

22 Hybrid Debt capital

instrumentIn this category, fall a number of capital

instruments, which combine certain characteristicsof equity and certain characteristics of debt.Each has a particular feature, which can be

considered to affect its quality as capital. Wherethese instruments have close similarities to

equity, in particular when they are able tosupport losses on an ongoing basis withouttriggering liquidation, they may be included in

Tier II capital.

23 Interest rate Risk Risks that the financial value of assets or

liabilities (or inflows/outflows) will be altered because of fluctuations in interest rates. For

example, the risk that future investment mayhave to be made at lower rates and future borrowings at higher rates.

24 Long Position A long position refers to a position where gains

arise from a rise in the value of the underlying.

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25 Market Risk Risk of loss arising from movements in market

prices or rates away from the rates or prices set

out in a transaction or agreement.

26 Modified Duration The modified duration or volatility of an interest

bearing security is its Macaulay durationdivided by one plus the coupon rate of the

security. It represents the percentage change in asecurities' price for a 100 basis points change in

yield. It is generally accurate for

only small changes in the yield.

dP 1

MD = ---- * ---

dY P

where:

MD = Modified Duration

P = Gross price (clean price + accrued

interest)

dP = Corresponding small change in price

dY = Small change in yield compounded with the

frequency of the coupon payment.

27 Mortgage Backed Security A bond-type security in which the collateral is

provided by a pool of mortgages. Income from

the underlying mortgages is used to meet interest

and principal repayments.

28 Mutual Fund Mutual Fund is a mechanism for pooling theresources by issuing units to the investors and

investing funds in securities in accordance with

objectives as disclosed in offer document. A fundestablished in the form of a trust toraise monies through the sale of units to the

public or a section of the public under one or more schemes for investing in securities,

including money market instruments.

29 Net NPA Net NPA = Gross NPA - (Balance in Interest

Suspense account +DICGC/ECGC claimsreceived and held pending adjustment + Part

payment received and kept in suspense

account + Total provisions held).30 Nostro accounts Foreign currency settlement account that a bank

maintains with its overseas correspondent banks. These accounts are assets of the

domestic bank.

31 Off- Balance sheet Off-Balance Sheet exposures refer to the

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exposures business activities of the bank that generally donot involve booking assets (loans) and taking

deposits. OO-balance sheet activities normally

generate fees, but produce liabilities or assetsthat are deferred or contingent and thus, do not

appear in the institutions balance sheets until or

unless they become actual assets or liabilities.32 Open Position It is the net difference between the amount

payable and amounts receivable in a particular

instrument or commodity. It results from the

existence of a net long or net short position in the particular instrument or commodity.

33 Option An option is a contract which grants the buyer the right, but not the obligation, to buy (calloption) or sell (put option) an asset,

commodity, currency or financial instrument at an

agreed rate (exercise price) on or before an agreed

date (expiry or settlement date). The buyer pays the seller an amount called the premiumin exchange for this right. This premium is the

price of the option.

34 Risk A possibility of an outcome not occurring asexpected. It can be measured and is not the

same as uncertainty, which is not measurable. In

financial terms, risk refers to the possibility of financial loss. It can be classified as creditrisk, market risk and operational risk.

35 Risk Asset Ratio A bank's risk asset ratio is the ratio of a bank's

risk assets to its capital funds. Risk assets includeassets other than highly rated governmentand government agency obligations and

cash, for example, corporate bonds and loans.The capital funds include capital and

undistributed reserves. The lower the risk asset

ratio the better the bank's 'capital cushion.

36 Risk weights Basel II sets out a risk-weighting schedule for

measuring the credit risk of obligors. The risk are

linked to ratings given to sovereigns, financial

institutions and corporations by external credit

rating agencies.37 Securitization The process whereby similar debt

instruments/asset are pooled together and

repackaged into marketable securities which can

be sold to investors. The process of loan

securitisation is used by banks to move their

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assets off the balance sheet in order to improve

their capital asset ratios.

38 Short Position A short position refers to a position where gains

arise from a decline in the value of the

underlying. It also refers to the sale of a

security in which the seller does not have a

long position.39 Specific Risk Within the framework of the BIS proposals on

market risk, specific risk refers to the risk

associated with a specific security, issuer or

company, as opposed to the risk associated witha market or market sector (general risk).

40 Subordinated Debt Refers to the status of the debt. In the event of the bankruptcy or liquidation of the debtor,

subordinated debt only has a secondary claim on

repayments, after other debt has been repaid.

41 Tier I Capital A term used to refer to one of the components of

regulatory capital. It consists mainly of sharecapital and disclosed reserves (minus

goodwill, if any). Tier I items are deemed to be of the highest quality because they are fullyavailable to cover losses. The other categories of

capital defined in Basel II are Tier II (or supplementary) capital and Tier III (or

additional supplementary) capital.

42 Tier II Capital Refers to one of components of regulatory

capital. Also known as supplementary capital, it

consists of certain reserves and certain

types of subordinated debt. Tier II items qualify asregulatory capital to the extent that they can be

used to absorb losses arising from a bank'sactivities. Tier II's capital loss absorption

capacity is lower than that of Tier I capital.

43 Trading Book A trading book or portfolio refers to the book of financial instruments held for the purpose of

short-term trading, as opposed to securities that

would be held as a long-term investment. The

trading book refers to the assets that are held primarily for generating profit on short- term

differences in prices/yields. The price risk is the prime concern of banks in trading book.

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44 Underwrite Generally, to underwrite means to assume arisk for a fee. Its two most common contexts

are:

a) Securities: a dealer or investment bank

agrees to purchase a new issue of securities

from the issuer and distribute these securities

to investors. The underwriter may be one person or part of an underwriting syndicate.

Thus the issuer faces no risk of being leftwith unsold securities.

b) Insurance: a person or company agrees to

provide financial compensation against the

risk of fire, theft, death, disability, etc., for afee called a premium.

45 Undisclosed Reserves These reserves often serve as a cushion against

unexpected losses, but they are less permanent in

nature and cannot be considered as ‘CoreCapital’. Revaluation reserves arise fromrevaluation of assets that areundervaluing on the bank’s books, typically bank

premises and marketable securities. The extent towhich the revaluation reserves can be reliedupon as a cushion for unexpectedlosses depends mainly upon the level of certainty that can be placed on estimates of themarket values of the relevant assets, the

subsequent deterioration in values under

difficult market conditions or in a forced sale, potential for actual liquidation at those values, tax

consequences of revaluation.

46 Value at Risk (VaR) It is a method for calculating and controlling

exposure to market risk. VAR is a single

number (currency amount) which estimates the

maximum expected loss of a portfolio over a given time horizon (the holding period) and at

a given confidence level.

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47 Venture Capital Fund A fund with the purpose of investing in start- up businesses that is perceived to haveexcellent growth prospects but does not have

access to capital markets.

48 Vertical Disallowance In the BIS Method for determining regulatory

capital necessary to cushion market risk, areversal of the offsets of a general risk charge of

a long position by a short position in two or

more securities in the same time band in theyield curve where the securities have differing

credit risks.

Risk Management in Banking Industry

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